Amazon (NASDAQ:AMZN) announced that it increased its share buyback program from $2 billion to $5 billion. The market liked the news, but the long-term effect of the buybacks should be more important to investors. Stock repurchase programs are one way that a company has to return cash to shareholders. This article studies the details of the buyback announcement.
The Amazon share buyback impact
The size of the buyback program relative to the market cap is minimal. As of December 2015, Amazon has 470.8 million shares outstanding. With the weak beginning for 2016, the lowest point of the stock trading range was $482. At the lowest price point, Amazon can repurchase roughly 10.4 million shares with $5 billion. Therefore, the total share count will be reduced by a mere 2.2%.
Considering that Amazon has roughly 19 million shares granted as stock based compensation (more specifically, as restricted stock units), the total number of shares that Amazon can purchase will not even make up for the further dilution that might come if all stock units are indeed vested. Amazon's buyback program is not likely to affect shareholder value in the long run.
For Amazon to purchase 20 million shares, and reduce the share count by ~4%, the stock price would have to fall to ~$250. That's possible, but extremely unlikely to happen.
A word on share buybacks in general
Stock buybacks only increase value to shareholders if the average price paid is low enough to generate a high return on capital. The goal of repurchasing stock is to earn high returns on invested capital. When companies repurchase stock, the goal is very much the same as it is for any other investor. That's because companies give up the opportunity to invest that capital in other business projects. In other words, by repurchasing stock, a company is giving up the opportunity to invest the same capital elsewhere. Therefore, the goal of buying back stock is to generate a return that is higher than its other business opportunities.
For that reason, when repurchasing its own stock is too expensive, Amazon is better off investing capital in other value generating projects. Value generating projects are those which have a positive NPV (net present value). That is, it generates more cash inflows than cash outflows over the life of the project.
Amazon has not repurchased stock since 2012, which it seems to be because there were better projects to invest in. For example, some of Amazon's good projects are the expansion of Amazon Fulfillment Centers and Amazon Web Services.
A little history about Amazon share repurchase program
Amazon's initial $2 billion stock repurchase program was approved by the board of directors in 2010. Since the approval, Amazon took advantage of the weak stock market period in 2011 and 2012 to repurchase $1.2 billion worth of stock. The remaining $0.8 billion of the program was never used, even during the weak stock prices of 2014. Amazon is truly opportunistic when it decides to repurchase stock, which speaks highly of management commitment to shareholders.
In my opinion, the recent buyback announcement is not going to have a large impact for investors in the near or long term. The likelihood of Amazon actually repurchasing shares at the current price level is minimal. I say this because at the current price, Amazon cannot buy back as many shares as it did in 2012. Additionally, Amazon's historical activity with share buybacks shows that a sudden decline in the stock is not enough reason to buy back stock.
Why did Amazon decide to increase the amount of buybacks?
I believe Amazon increased the amount of capital that can be invested in stock buybacks because there are many advantages with a buyback program.
The first and most important advantage is to take opportunity of a stressed stock market to add value to shareholders. Companies can't just decide to buy back stock out of nowhere because the decision must be approved by the board of directors. Amazon's recent announcement was simply to communicate to shareholders that the total amount of potential buybacks will be larger.
Additionally, the announcement of a share buyback increase is typically well accepted by the stock market. It indicates that management thinks the stock is undervalued and repurchasing shares is worth the investment. Therefore, the move to increase the amount of the share repurchase program might have been directed to public opinion. However, I doubt public opinion is the main reason Amazon increased the buyback program.
Furthermore, a stock buyback can be employed to make changes in the capital structure of the company. As of now, there doesn't seem to be any intent of Amazon to change its capital structure. However, if a bond issuance follows the stock buyback announcement, then the intention to change Amazon's capital structure will be more apparent. Particularly if the bond issuance neighbors the $5 billion approved for stock buybacks. Currently, there are no signs that Amazon will issue any bonds.
Another advantage of a stock buyback is that not only can it increase EPS (earnings per share), but it also can boost the percentage ownership of current shareholders. However, this is not the case with Amazon at current prices because the potential number of shares to be reduced is minimal compared to the total shares outstanding. See below a graph of Amazon shares outstanding. Note the constant increase of shares outstanding.
What is Amazon telling the market with its share buyback?
Since management is careful at executing buybacks, the biggest clue that the market will get from this buyback program is when Amazon actually executes and buys back shares. The action of buying back shares will indicate that AMZN's stock is undervalued per management views. For the market to take this clue, the amount of shares repurchased will be very important.
If Amazon uses more than half of the repurchase budget in a given quarter, then it is likely that management truly sees the shares undervalued. For management to spend (or invest) $2.5 billion in its own stock, the stock has to be trading at an attractive price. Amazon has never bought back stock for more than $1 billion in a given year.
If Amazon uses somewhere around 25% to 50% of the repurchase budget, then it is going to be harder to determine whether Amazon truly sees shares undervalued or there just isn't any other opportunities to invest the capital. If Amazon uses less than 25% of the $5 billion, then it might be a public relations effort to send a positive signal to the stock market.
Shareholders of Amazon should applaud the approval of $5 billion for stock buybacks. But more importantly, shareholders of Amazon should applaud management for their diligence and care in executing share buybacks. In my opinion, management has been very diligent at executing the previous buyback program, which benefits shareholders in the long run.
Unfortunately, the $5 billion approved for stock repurchase is not going to move the needle for reducing share count. Amazon's stock price is highly priced for $5 billion to make a difference. As top author Brian Nichols asserted in his last Amazon article, if Amazon launches something bigger in the future, then it could have a large impact in the stock price. The current buyback program remains too small relative to Amazon's size.
Nonetheless, this is an event that should be in every shareholder and potential investor's radar. The action of executing the buyback is much more important than the announcement to do so.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.